Why would the smartest man in the room assume this type of mortality and longevity risk with of all things, variable annuities? The devil is always in the details, so let me give you Stan The Annuity Man's take on why I think Warren did the deal.

Before we jump into the details, the first warning I need to convey is that coming soon to the next round of bad annuity lunch seminars and annuity Internet pop up ads will be the following statement: "Warren Buffett loves annuities!"

Already, there are annuity industry leaders that are trumpeting Mr. Buffett's recent entry into the business. One of the quotes I read from a CEO of a major variable annuity issuer was: "It's very encouraging to see smart money coming back in the variable annuity space."

Hold on Sparky! That's a pretty big broad brush you have there and I'm not sure you can sum it up that quickly, even though it sounds good for the annuity industry.

First of all, Cigna used to be a major player in the variable annuity world, but began winding down its annuity business more than a decade ago. It appears that Buffett is only reinsuring the obligations currently on the books, and has no interest at all in any new variable annuity policy guarantees that are being issued today.

Buffett's a smart guy, so I'm sure that he looked at the actuarial life expectancy of the policies, and factored in what I call "the rider procrastination factor." This Stanism (Stan The Annuity Man speak) is based on an industry estimation that over 60% of lifetime income riders are never turned on by the policy owner. In other words, the person bought the annuity guarantees for a future lifetime income stream, but never seem to turn that switch on. Typical of Americans to have the lifetime benefit and never access it, and I'm sure that Buffett factored that into his decision to reinsure these Cigna policies.

It's important to point out that Berkshire is backing up Cigna policyholders that have Guaranteed Minimum Death Benefits and Guaranteed Minimum Income Benefits. These benefits are attached to variable annuities as "riders,” which are contractually guaranteed attachments to a policy.

Variable annuities are a tax-advantaged way to invest in mutual funds (aka: separate accounts). However, most policies are sold with attached benefit riders in order to attract investors with these enticing contractual guarantees under the "you can have your cake and eat it too" closing technique.

In 2008 when the markets took a major hit, these guarantees became major balance sheet liabilities to carriers as you can well imagine. If we ever see another major market downturn, there will be a major scramble to offload these types of guarantees, and Mr. Buffett's phone will definitely ring off the hook.

A recent article in The Wall Street Journal, "New Annuity Guarantees Raise Questions”, by Leslie Scism points out that regulators "are worried that lifetime income guarantees sold on a mass scale could be harmful to insurers' financial health if markets were to slide as they did in 2007-09, putting insurers on the hook for massive payouts."

History has a tendency of repeating itself, and insurance carriers are scrambling to make sure that they have enough reserves to back up the contractual guarantees in place and new ones being locked in every day.

To add to this continuing concern, many variable annuity issuers are now offering buybacks of these contractual guarantees. Yes, some carriers are actually offering cash to policyholders to void these guarantees in order to lessen the carrier's ongoing risk. If there is another major dip in the market, these buyback offers will definitely increase.

Warren Buffett is usually the only person available and willing to accept these types of risks, and predictably charges a premium to perform this type of service. But in this specific case with Cigna, I think that his risk is minimal because he is reinsuring a dead (no pun intended) book of business. Pretty shrewd move in my opinion Warren! In essence, Buffett is betting that Berkshire Hathaway's continuing investment performance will exceed the inherent longevity risk of the annuity guarantees. History says that he is probably correct.

Annuities are really just "transfer of risk" products. In the case of an income annuity as an example, the insurance company is accepting the risk of paying you for as long as you live. You are transferring the risk to the carrier to pay you for life. In Cigna's case, they are transferring the risk to Buffett's Berkshire Hathaway to guarantee the transfer of risk benefits that Cigna originally issued. What goes around comes around, I guess.

So does Warren Buffett love annuities like the future ads you will see from your local broker or annuity Internet promoter. The answer is a resounding NO. Warren Buffett loves only one thing ... making money, and he's still pretty darn good at it.

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